Please, click here to read this article in pdf format:august-10-2010 In our last letter, we had suggested that: “…in the absence of any catalyst for a further widening of the 3-mo Euribor-OIS spread vs. 3-mo Libor – OIS spread, the risk rally (i.e. gold, stocks, oil, credit, Euro) that we have witnessed in the last [...]
Please, click here to read this article in pdf format:august-10-2010
In our last letter, we had suggested that:
“…in the absence of any catalyst for a further widening of the 3-mo Euribor-OIS spread vs. 3-mo Libor – OIS spread, the risk rally (i.e. gold, stocks, oil, credit, Euro) that we have witnessed in the last weeks should remain range bound…”
Well, the European “recovery” should be a catalyst in itself. As the system recovers, so do financials, lessening their dependence on liquidity lines from the European Central Bank and driving Euribor higher. This provided support to the recent Euro rally, when USD weakness widened the interest rates differential between currency zones. As the chart below shows (source: Bloomberg), the spread 3-mo Euribor-EONIA and 3-mo Libor – OIS continued to widen yesterday. Yet, the Euro after having topped just above 1.33, steadily dropped during the session.
Have we found a reversal in the Euro? It maybe early to tell, but the fact that it dropped with the rates spread widening caught our attention. We are aware some will suggest that it was a mere correction within a consolidation. After all, the currency has been enjoying a relentless ride. Also, it has not even touched its support at 1.3130. However, yesterday was also a day of widening in Euro zone sovereign spreads. All this, with stocks closing higher.
Dos this make sense?
The market is completely focused on the FOMC meeting taking place tomorrow. Essentially, the Fed can hint that they will somehow (via reinvesting in mortgages or bills) increase the supply of liquidity or…not. We think nothing will be hinted tomorrow and in the absence of further news, the market may refocus on the unsolved problems in the Euro zone, which may be behind the performance of the Euro and sovereign credit default swaps yesterday. As we wrote before, we can’t see a rationale for the Fed to buy the securities that the market is already buying and stocks and commodities are not dropping. Perhaps, we suggest the Fed should even begin to think about how to further tighten, before it is too late.
In the meantime, things in Europe have not really improved. Yes, everyone tells us that the stress tests provided more transparency, but that is a polite way to say we were told that which we knew. One thing that caught our interest is the fact that on August 5th, the Greek government announced EUR25BN in guarantees for Greek banks. In total, Greek banks now count with EUR55BN in government guarantees.
What are these guarantees for? For Greek banks to be able to raise money!
From the market? No, from the European Central Bank, with the guarantees as collateral!
What is the liquidity being raised for? To further lend to the government!
Then why does the European Central Bank not buy Greek government bonds directly? Because this way there’s a shortcut for the Central Bank to avoid having to sterilize the purchases.
Why? To not drive refinancing , EONIA and Euribor rates higher…
Martin Sibileau
